Martin Dwyer - HMRC National Technicians
Paul Burden - HMRC National Technicians
Martin Delnon - HMRC PAYE Technical
Mike Harmon - HMRC PAYE Technical
Kevin Madley - HMRC RP International
Cathryn Kay - Ernst & Young LLP
Steve Wade - Ernst & Young LLP
Barry Cocks - KPMG LLP
Philip Paur - Deloitte & Touche LLP
Matthew Fox - Grant Thornton
Liz Morgan - PricewaterhouseCoopers
Eleanor Meredith - PricewaterhouseCoopers
The meeting took place at the offices of Grant Thornton, Grant Thornton House, Melton Street, Euston Square, London NW1 2EP.
Dwyer opened the meeting by explaining that its purpose was to give interested parties an opportunity to understand HMRC's position regarding the taxation of bonuses in general and LTIPs in particular. Dwyer was aware of ongoing correspondence in a number of enquiry cases where this issue was in dispute. It was his intention to provide some simple explanatory examples following the outcome of today's meeting which could be used both to advise staff within CPTT and share with our external contacts. Hopefully, these examples could address the international dimension which Dwyer was aware was also causing customers and their advisors difficulty, particularly in respect of foreign tax credit relief claims. Matthew Fox had also requested some clarity regarding the corporate treatment of bonus payments and how businesses could ensure that the appropriate relief for UK CT purposes could be obtained, observing existing legislation and current transfer pricing rules.
Dwyer asked Mike Harmon to explain the position of HMRC with regards to the question of the basis of assessment. Harmon explained that we were not looking at receipts basis here but were seeking to establish the year that these earnings were for. Statute was unhelpful in this regard but Case Law had considered this issue and reference thereto enabled a conclusion to be drawn following establishment of the relevant facts. Harmon explained that the HMRC approach was relatively simple. Even in complex schemes (including LTIPs and Phantoms) we look to identify when the employee gets unfettered entitlement to earnings. HMRC will look at the relevant documentation to determine what the plan intends to achieve. Harmon confirmed that in his experience, such schemes may provide both reward for past performance and 'golden handcuffs' for the future. An element of conditionality was normally attached to the second of these intentions. Where such conditionality provided a cliff edge approach, with no accrual, HMRC will argue that the earnings are for the year when the conditions are met. Harmon posed the question, if the parties fell out, what would the employee sue for?.
Barry Cocks asked about the impact of milestones which provided for delivery of earnings. Harmon confirmed that if the plan documentation provided evidence of accrual then apportionment by reference to the earnings period would be relevant, but if cliff edge conditions applied then HMRC would argue that there was no accrual and that the earnings were for the year in which the conditions were met.
Harmon acknowledged that a typical plan may show a reference period as being one in which an employee is able to distinguish himself but this reference period did not necessarily determine the period which the earnings were for. In the initial reference period the individual simply demonstrates their value to the employer and in consequence is invited to participate in a scheme, the intention of which is, to tie them into employment for a period of time.
Steve Wade asked for clarification of HMRC's position in an example where a bonus was earned over a calendar year based on the employee's (and the employer's) performance but was payable in the May following the bonus year end (but not payable if the employee left before the payment date). Harmon explained that if the employee gets nothing if he leaves the employment before the end of May, HMRC would argue that any bonus payment received was for the year in which the particular month of May fell.
Eleanor Meredith quoted the case of Heasman v Jordan and suggested that the line which Harmon was advocating was in contradiction to the findings in this case. She made the point that in that case discretionary bonuses were paid to certain employees who remained in employment at the end of the war years. The bonuses were held to have been earned over the war years notwithstanding that various employees who would otherwise have received the bonuses had left employment in the interim and therefore received nothing. In practice, almost all discretionary bonuses were not payable if the employee left employment before the payment date. Harmon confirmed again that if the individual leaves before the condition date he is not entitled to anything.
Steve Wade argued that bonuses can be earned but not delivered. Philip Paur referred to cases of Bray v Best and Hamblett v Godfrey as support for his argument that earnings are earned during and therefore 'for' a period before any condition lifts. Harmon responded by explaining that conditionality was referred to in the case of Hunter v Dewhurst (16TC605). This was approved up to the level of the House of Lords.
Paur was looking at modern performance plans which were intended to incentivise. He pointed out that a lot of effort goes into designing these plans and it is therefore important that advisors understand how they are to be interpreted. Harmon agreed that there were many cases which could be quoted in this discussion but explained that Bray v Best was the most recent and the findings in this case were clear. HMRC recognise what incentive plans are seeking to achieve and that they frequently provide incentives by looking forward. HMRC have no problem with incentives with milestones with no conditionality but if there is a risk of forfeiture or any conditionality, Harmon struggled to understand how entitlement could accrue where the scheme documentation created a cliff edge.
Barry Cocks asked for clarification that if a bonus with conditions attached was earned within a reference period when an individual was resident/ordinarily resident in the UK but matured when he was not resident following the meeting of a condition, what would the view of HMRC be regarding assessment. Harmon confirmed that in those circumstances he would accept that the bonus was not taxable in the UK as it would be for a period when the individual was not resident in the UK (and performs no UK duties).
Paur didn't feel that this analysis was consistent with a legal decision (identity of case not given) where an attempt to defer payment from one tax year to another was unsuccessful. In addition, a recent Special Commissioners' case (Barrett) had resulted in a decision that a bonus was deferred earnings from a previous year. Paur offered his opinion that agents would anticipate that courts would take a more rounded view in contrast to the cut and dried position outlined by Harmon.
Harmon replied by confirming that HMRC's position was based on the Dewhurst case. He also made it clear that this position had been consistent for many years as could be evidenced by the available guidance within HMRC.
Steve Wade explained that there were so many existing agreements which did not follow the stated HMRC position. Dwyer confirmed that there may well be some old agreements which remain in place which do not correctly reflect the principles outlined within HMRC guidance. Where such agreements are reviewed by HMRC he hoped that they would be withdrawn or replaced with something which more accurately reflects the HMRC technical position. Nevertheless, he accepted that until such time as these agreements were withdrawn, particular customers were able to use them.
Barry Cocks pointed out that bonuses delivered when an individual was resident in the UK but earned by reference to a period when not resident would (under the HMRC analysis) be taxable in the UK if any conditions were lifted during the period of UK residence but may also be taxable in another country, particularly the US. Madley explained that the treaty didn't remove the UK's domestic taxing rights, but it could override them. There were similarities with the OECD view of how share options should be treated. Madley appreciated that there may well be some difficulties around the correct sourcing of bonuses for treaty purposes and indicated that there was an opportunity to put this issue as an agenda item for the imminent UK/US treaty review. He recognised that sourcing did present a difficulty and that a mismatch was inevitable. Madley pointed out that under the competent authority procedures, the US and the UK would mutually agree how this particular issue should be resolved.
Harmon pointed out that the language often used around LTIPs and other incentive arrangements was similar to that relating to securities (Eg vest, grant, option etc) but this is not appropriate. LTIPs and phantom share schemes work with cash. There is no 'grant' or 'vesting'. Harmon recognised the appeal of spreading the growth across a period but reminded agents that this very argument was used by HMRC in the case of Bray v Best and the outcome was that HMRC lost the case. Bray v Best went to the House of Lords in 1988. The Court of Appeal judgement contained a summary of case law spanning the 20th century. This was approved by the House of Lords. It is, therefore, not possible to argue that early case law is unhelpful when interpreting 21st century reward packages.
Cocks explained that there was a real practical difficulty with HMRC's approach. The outcome was inconvenient when compared to other international fiscal authorities. Harmon conceded that this may well be the case and pointed out that if evidence suggested that the UK was out of step then possibly this could be debated going forward.
Wade explained that the sourcing mismatch would result in numerous referrals for competent authority treatment.
Dwyer recognised that there was a lack of clarity within HMRC regarding the precise basis upon which foreign tax credit relief should be calculated where bonuses were regarded as 'for' the year in which any conditions lifted. It was agreed that Madley and Burden would work together to clarify the position of HMRC in this regard and feed into the aforementioned examples which would be shared with those present at the meeting before being issued as general guidance.
Paur confirmed that his firm had obtained Counsel's opinion from Michael Sherry which did not accord with the views being expressed by Harmon. Harmon explained that he last took Counsel's opinion on this issue in 2005. As he saw it there was no intention for HMRC to move away from their stated position. Harmon did however recognise that the concessionary cash basis referred to in IR212 and TB31B may have added confusion to this issue. Although it did not specifically say so, this concessionary cash basis was only intended to apply to simple accruing bonuses with no conditionality.
At this point Dwyer explained that those present should fully appreciate the position of HRMC and the legal precedents upon which this was based. For the sake of clarity he summarised what HMRC had agreed to do:
Wade explained that although these issues had been discussed with HMRC previously, it had not been made clear what was meant by the term 'conditions'. Agents certainly didn't think that this applied to simple leaver provisions around bonuses. Harmon made it absolutely clear that the conditionality which he had referred to included any condition whatsoever which had to be met before unfettered entitlement to payment arose.
Burden confirmed that this matter not only affected SA reporting but also employer reporting for PAYE purposes. Employers would need to understand the correct treatment to apply to bonuses and ensure that their reporting was consistent.
Paur explained that acceptance of the HMRC proposals may present difficulties because of the US resourcing rule and the statute of limitations. Where insufficient foreign tax credit relief had been claimed in the US it was not always possible to submit claims for earlier years. Dwyer confirmed that he understood this but that it was possible for unused credits to be retained and be available for use over a forthcoming ten year period. It was not entirely true therefore to say that credit was not available. Burden also pointed out that individuals could elect to be assessed on the accruals basis in the US which opened up the possibility of claiming foreign tax credit relief for earlier years.
Matthew Fox asked for clarification of HMRC views regarding penalties, should it be found during an enquiry that bonuses had been reported on an incorrect basis and as a consequence, that an understatement had arisen. Dwyer could not give any assurance that penalties would not be chargeable but explained that, as always, negligence would need to be shown. However, he recognised that there was some difficulty in this area and confirmed that HMRC would take a sympathetic approach, particularly where bonuses had been reported albeit on the wrong basis.
Finally, Paur asked how best agents could take forward the matter of lobbying the UK to point out that our treatment of bonuses was inconsistent with the International position. Dwyer suggested that this could be referred to HMRC by CIOT through the medium of the Joint Forum on Expatriate Tax and NICs. Harmon confirmed that he would be interested to see any evidence that the 'Big 4' held to show that the UK position was not in step with its international counterparts but could give no encouragement that this would lead to a shift of HMRC's long held standpoint.
Please note that following this meeting HMRC have received additional correspondence from external representatives outlining their disagreement with the stated HMRC position and requesting further clarification and an opportunity to continue the debate. This was addressed at the Joint Forum on Expatriate Tax & NICs meeting held on 5 December 2007 and further dialogue will follow.
